By Clive Burstow, Head of Global Resources at Barings.
Rethinking the Energy Transition
Despite the various Net Zero commitments from countries around the world, global temperatures are set to increase by 1.8-2.7°C by 2050. This requires us to rethink the energy transition.
It is well understood that to achieve Net Zero by 2050, we need to transition the energy matrix from one that is fossil fuel-based to one that relies heavily on renewable energy. This transition will need substantial investments in solar and wind generation capacity, which requires mining significantly higher amounts of raw materials—including copper, aluminum, and nickel—than we have in the last 30 years. What is less well understood is the impact that this transition will have on the materials used in everyday construction such as steel and cement. Also pressing, and arguably more contentious, is the amount of energy that will be required to drive the transition. Based on our projections, and perhaps somewhat counterintuitively, natural gas and oil will remain a critical component.
The Key Role of Raw Materials
Our estimates show that to achieve Net Zero by 2050, we will need to transition between 55-70% of the global power grid to run on renewable plus transition energy (natural gas and nuclear power), which means that 30-45% of our power supply will still come from what are termed fossil fuels. Today, approximately 85% of our energy comes from fossil fuels with the remaining balance coming from various renewable energy sources1.
This means that as investors, we will be required to balance the potential benefits to companies of investing in new energy sources against the potential costs that companies will incur if they choose not to invest in these areas. At Barings, one way we have sought to do this is by enhancing our established ESG process to add a ‘cost of carbon’ to the Cost of Equity calculation that we use to derive our investment price targets. Through this, we are able to assess the cost of carbon to a company. We then combine this assessment with our understanding of the investments that the company will need to make to reduce its own carbon emissions as part of the effort to reduce global emissions. Ultimately, this allows us to form a holistic view of the economic impact carbon will have on our investments.
Generators of the Transition
While renewable energy corporates, mainly wind and solar, will be the key beneficiaries of the transition, we would argue that these companies—which we classify as generators—account for only half of the energy transition debate. For instance, 2022 showed that while this sector offered long-term opportunities, in the near term, it did not necessarily generate a healthy return, largely due to the impact of rising raw material prices and lower levels of wind.
These challenges highlight the importance of considering other forms of energy, such as hydrogen and biofuels. At the same time, when it comes to fossil fuels, natural gas is an obvious area of investment as a transition fuel, owing to its lower carbon intensity. And applications for oil also remain—especially given that a wind turbine requires two barrels of oil, synthesized into a lubricant, each year to keep its turbine spinning2.
Enablers of the Transition
Alongside the generators, there are companies that enable the transition—including mining companies, steel producers, chemical processors and construction raw materials producers. The reality is, without a significant increase in the production of steel, copper, aluminum, cement, lithium, and rare earths, it will be almost impossible to achieve Net Zero by 2050. For instance, while a thermal coal power plant requires around one ton per MW of copper, an offshore wind turbine requires eight to 10 times that amount3.
While some investors have been historically reticent to commit capital to what they view—for now—as a carbon-intensive industry, there is a growing understanding of the role these companies will play in the energy transition. At the same time, they are decarbonizing their own production chains, and increasing (at the margin) their attractiveness to investors. With annual supply-demand deficits in commodities such as copper and aluminum growing larger and larger, and limited investment in new mines because of the time, cost, and regulatory burden to build them, the imperative to expand capacity through commissioning new mines is increasing by the year. The scarcity of these commodities, combined with the growing demand for them, will, in our view, eventually drive commodity prices higher in order to incentivize new supply—ultimately benefitting the enablers of the energy transition.
Takeaway
By embracing all of the components of the energy matrix, including the raw materials sectors that have fallen out of favor among many investors, the goal of reducing carbon emissions to Net Zero by 2050 seems achievable. Ultimately, the journey will require effort, time and money. But one premise that is becoming increasingly clear is that when it comes to mitigating the impacts of climate change, natural resources companies are a crucial part of the solution, not the problem.
1Source: Barings. As of December 2022.
2Source: Barings’ estimates.
3Source: IEA. As of March 2022.
For Professional Investors / Institutional only. This document should not be distributed to or relied on by Retail / Individual Investors. Any forecasts in this material are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Barings is the brand name for the worldwide asset management or associated businesses of Barings. This document is issued by the following entity: Baring International Fund Managers (Ireland) Limited), which is authorized as an Alternative Investment Fund Manager in several European Union jurisdictions under the Alternative Investment Fund Managers Directive (AIFMD) passport regime and, since April 28, 2006, as a UCITS management company with the Central Bank of Ireland. 23-2765847
